Politicians are always generous with other people’s money… until it runs out.Near the peak of the late-’90s tech bubble, California’s legislature passed the largest pension increase in its history.Today, with as much as $750 billion in unfunded public pension debt, California has one of the worst pension situations in the country. But it’s far from alone.Illinois has a staggering $250 billion in unfunded pension obligations. State pension plans in Connecticut, Pennsylvania, New Jersey, and many other states are taking on water, too.Unfunded public pension liabilities in the US have surpassed $5 trillion.

Taxpayers Are Stuck With the Bill

There used to be a simple formula for a secure retirement. American workers would work for a big company for decades. Then, at a certain age, they were eligible for a monthly pension check… for life.Once common, pensions have virtually disappeared from the private sector. Today, less than 4% of companies offer them. It’s another vector in the devalued standard of living of the average American.Essentially, only government employees get pensions now.The government isn’t subject to the same constraints as the private sector. So it has no problem promising benefits it can’t afford to pay.That’s because government revenue doesn’t come from the voluntary exchange of goods or services. It comes from taxes, which it extracts via coercion.Politicians only care about the next election. So there’s no way to hold them accountable in the long term.They automatically do the most expedient thing in the short term, like promising extravagant pension benefits. In the long term, their successors have to deal with the consequences.Naturally, not one of the politicians who voted for California’s record pension increase is still in office.It’s bad enough that politicians give themselves and other state employees extravagant retirement benefits and stick the taxpayers with the bill.But the story gets worse…Government pension plans use all sorts of accounting wizardry that would land someone in the private sector in prison.

Bernie Madoff Math

The single most important number for a pension plan is its assumed rate of return. This is the rate the plan’s investments are expected to make.As in other areas of life, the government takes special privileges here. It uses accounting practices that the private sector can’t—not legally, anyway.Essentially, government pension plans choose whatever rate of return they’d like.Lawrence McQuillan—a senior fellow at the Independent Institute—says that government pension plans “work on the assumption that they’re going to generate returns 25% higher than Warren Buffett every single year into perpetuity.”These assumptions are totally disconnected from reality.Government pension plans overestimate investment returns using unrealistically high rates of return. They routinely pull numbers out of thin air.The results they come up with are insane.In effect, this artificially shrinks a pension fund’s liabilities, making it look more solvent than it really is.In other words, the government is using Bernie Madoff math.This lets politicians contribute less money than the fund needs to be truly solvent. That, in turn, frees up money to bribe constituents for votes, or do whatever else the politicians want.On average, government pension plans assume about a 7–8% rate of return (even after years of underperformance).

False Assumptions

A recent study found that the average 2016 return for a public pension was an awful 0.6%, compared to an average assumed return of 7.6%.At those assumed rates, a dollar invested today would double in around nine years. This rosy assumption allows a pension plan to say, for example, that $25,000 in the fund today will cover a $50,000 obligation in 2026.

California’s public employee pension plan is the largest pension plan in the US. It recently voted to reduce its assumed rate of return from 7.5 to 7% over three years.The move—which doesn’t go nearly far enough—generated enormous political controversy.Lowering the rate of return to a more realistic number, if even slightly, means politicians would need to contribute more to a pension fund. That means drastic spending cuts or higher taxes elsewhere.This is why, in most cases, it’s politically impossible for a government pension plan to stick with anything close to realistic assumptions.

The Biggest Financial Bubble in World History… and Pensions Are Still Broke

In the ’50s and ’60s, government pension funds were, on average, over 90% invested in bonds and cash.Most importantly, they were structured so that assets matched future liabilities. It was conservative, and it made sense.That’s not how public pensions look today.Matching liabilities with safe fixed income investments has become impractical, thanks to the Federal Reserve and the historic bubble it’s created in the bond market.The economy has been on life support since the 2008 financial crisis. The Fed has pumped it up with unprecedented amounts of “stimulus.” This has created enormous distortions and misallocations of capital, especially in the bond market.Think of the trillions of dollars in money printing programs—euphemistically called quantitative easing (QE) 1, 2, and 3. In short, the Fed created trillions of dollars out of thin air and used them to buy up bonds, creating an epic bubble.Meanwhile, with zero and even negative interest rates in many countries, rates are the lowest they’ve been in 5,000 years of recorded human history.What’s happening in the bond market could not happen in a free market. It’s only possible in the current “Alice in Wonderland” economy created by central bankers.This is not hyperbole. We’re really in uncharted territory. (Interest rates were never lower than 6% in ancient Greece and ranged from 4 to over 12% in ancient Rome.)Allegedly, the Fed has done all of this to save the economy.In truth, it’s warped the economy and turned the bond market into the largest financial bubble in human history.This, of course, affects pensions.First, today’s artificially low interest rates make it very difficult to match future liabilities with income from bonds at a reasonable cost. So pensions have had to turn to riskier assets like stocks, real estate, and alternative investments.With interest rates near all-time lows, bond prices are at an all-time high. That benefits pension plans because it pumps up asset values and makes the funds look more solvent.But, even with the bond market in a historic bubble…Even with the stock market at all-time highs and more overvalued than almost ever…And even with the Bernie Madoff math…Public pensions are still insolvent.Despite the eye-watering returns in the bond and stock markets over the past 10 years, pension liabilities have still gone up.According to Moody’s:The optimistic "best case" of cumulative 25% investment return would reduce net pension liabilities by just 1% through 2019 year-end because of past bad investment returns and weak contributions. Meanwhile, the "base case" scenario of 19% returns would see net pension liabilities rise by 15%.This is an unsolvable problem.Many public pensions are hopelessly insolvent. It will all be apparent in the next market downturn, which probably isn’t far off.I think we’re headed into an enormous crisis.

* Base metals are showing signs of real strength, with prices across the complex breaking out, or threatening to do so.* Copper and zinc have looked the strongest of the bunch and both have recently broke out of multi-month consolidation patterns.

* The moves we are seeing have the hallmarks of a supply (destruction) driven rally, which tend to be sharp and ferocious in nature.

* An industry-wide decline in reserve quantity (depletion) and quality (grade), accompanied with a complete lack of new discoveries means we believe we're likely to see an increase in M&A as prices begin to rise, which is why we're interested in quality exploration and development stage plays.

Every now and then you get a feeling that the market is sending a message. Last week was one of those weeks as we witnessed a whole host of commodities either breaking out of multi-month consolidation patterns, or seriously threatening to do so.

The topside moves were generally spread across the commodity complex, but by far the most significant moves were seen in the base metals where we witnessed breakouts across the board, some in rather spectacular fashion.

From a higher level, this is best shown in a chart of the Bloomberg Industrial Metal Index, which has now broken out above a down trend that has been in place since the index peaked way back in 2007, over a decade ago.

When we dive into the individual metals, the recent top performers have undeniably been zinc (+ lead) and copper, both breaking out of multi-month consolidation patterns over the last few weeks to new multi-year highs.

This is not surprising to us given the strong fundamental drivers we see impacting the industry (largely supply side) and the moves we are seeing have all the hallmarks of one of Rick Rule's favorite sayings playing out in reality - "Bear markets are always the authors of bull markets".

That is because we are finally seeing signs of real supply destruction as a result of the brutal five to ten year bear market we've experienced in the commodity complex. Crucially for investors, it appears as though this is also starting to have an impact on commodity prices.

So, let's take a closer look at two of the more dramatic movers - zinc and copper.

Zinc:Zinc in particular has looked extremely strong and you can clearly see the week's breakout on the chart below. The metal most commonly used as a galvanizing agent now appears to have successfully consolidated its 2016 run, which saw it claim the status of the best performing metal last year (with the exception of iron ore).

As of its close on Friday, the zinc price is up 115% from its January 2016 low of $1,440/t.

Zinc's run has all the hallmarks of a supply (or lack thereof) driven move, which tend to be swift and devoid of major pullbacks or periods of choppiness.

This is supported by the hard data, which shows that since 2012, we've seen over 1 million tonnes (Mt) of shuttered production in a 13Mt market*1. Glencore alone (the world's largest zinc producer) cut its zinc production by 24% in 2016, a year which also saw the closing of two of the world’s major zinc mines in Century (Australia) and Lisheen (Ireland).

We have been hearing of potential tightness in the zinc market for a while now, only to see "hidden" supply (likely of Chinese origin) dumped on the market whenever prices rallied.

However, this dynamic seems to have completely changed and Chinese figures now show the country is dealing with a significant mined deficit caused by declining production from the countries domestic mines.

Last week’s news that the Chinese government ordered a shutdown of all the lead and zinc mines in the Hunan province's Huayuan county (a major zinc producing region) suggests that the countries zinc deficit is only likely to grow in the near to mid-term, further adding to the already strong tailwinds currently affecting the zinc price.

Copper:

Whilst not quite as spectacular as zinc, copper has shown signs of a real resurgence in 2017.

The move started late in 2016 after the copper price ground out a text book basing pattern throughout the first three quarters of the year before breaking out proper in November.

2017 saw those gains consolidated as price traded in a sideways range before leading the base metals complex in breaking out topside a few weeks ago back in late July. Price is currently testing the key $3/lb level, as shown in the chart below..Figure 3: Weekly copper price candlestick chart, as of Friday, 18th of August, 2017. Source: Thomson Eikon

As with most commodities we follow, we believe the most reliable drivers of the copper price into the foreseeable future are going to come primarily from the supply side of the equation. This is because we know that the industry is mining well above its reserve grade, meaning that over time the industry average mined grade is almost certain to decline.

Lower mined grades mean miners will have to increase the volume of ore they process every year, just to "tread water". It also means we're likely to see a climbing industry wide average cost of production (less copper produced per ton of ore mined/processed), increasingly rendering mines at the higher end of the cost curve uneconomic unless the copper price rises enough to compensate for the declining grades.

A text book example of this phenomenon can be seen at the Escondida mine in Chile, currently the largest copper mine in the world, producing over 5% of global annual supply.

The Escondida mine is currently mining ore that grades around 1% Cu, which is 1.4 x the life-of-mine reserve grade of its sulfide ore body, which currently sits just under 0.6% Cu. In other words, the mine is being "high graded", meaning simple mathematics dictates that mine grades are set to steadily decline into the future.

This phenomenon is clearly visible in BHP's (57.5% owner) 2016 operational update which highlighted a huge 28% year-on-year decline in mined grade during the year.

Whilst part of the decline was due to grade variability within the ore body, it highlights a trend of a declining grade profile that's only going to worsen over time.

This problem is by no means limited to Escondida, but rather is pervasive across the entire copper sector. With the world’s copper mines not only rapidly depleting in absolute terms (depletion), but also falling in quality by way of grade decline (result of high grading), we believe we're likely to see significant downward pressure on the amount of the copper the industry is able to produce.

Completely ignoring the demand side of the equation (which is harder to quantify, but we are generally bullish on - think the increasing push towards electrification), an industry wide flat to declining production profile is usually a key ingredient in the recipe for higher prices.

To compound matters, low copper prices have all but killed the copper exploration sector, both at a brown fields (near existing mines) and green fields (new discoveries) level. The result, with a couple of notable exceptions, is that there is almost nothing in the way of new world-class copper projects ready to replace depletion from existing stock of copper mines.

This is why we are paying particular attention to exciting exploration projects, new copper discoveries and the few existing high-quality development plays which we believe are becoming increasingly attractive acquisition targets as the copper market turns and producer are forced to look at options to replace their rapidly depleting reserves.

I wanted the focus of this article to be on zinc and copper, however it's important to note there have been equally as important moves elsewhere in the sector, particularly in the metals that are leveraged to the rapidly growing lithium ion (Li-ion) battery sector like nickel and cobalt.

Nickel:

For example nickel, has been slowly but surely attempting to grind out a base over the past 18 months. This is shown on the chart below with the June/July low potentially forming the first major "lower high" since way back in 2011.

Nickel prices peaked at almost $54,000/t back in 2007. This means that at the current price of just under $11,000/t, the key ingredient in stainless steel is still down almost 80% from its peak seen over a decade ago, making it probably the single most contrarian metal within the base metals complex.

Nickel prices have shown a recent bout of strength, moving higher over the past few months and are now threatening to break out above the 2016 highs of $12,000/t - a key level to watch.

At face value, the fundamentals driving the sector look less favorable than the likes of zinc or copper (near record high warehouse inventory levels being key). However, there are enough green shoots out there to suggest it's a metal that's at least worthy of adding to your watch list.

One of the key drivers to watch is the growth of the electric vehicle and Li-ion battery industry, where nickel is a key (and becoming increasingly important) ingredient in most battery chemistries.

It's difficult to predict the growth of the Li-ion sector (an industry prone to hyperbole), however the demand it is generating looks to be already having an impact, with nickel inventories declining for the first time in half a decade in 2015/16 in a world of flat to slightly increasing global mine production.

Whilst it's far from a perfect indicator, I am also keeping a close eye on warehouse inventory levels as I believe an increase in the rate-of-decline will be a key "tell-tale" that the supply/demand balance is moving in favor of higher prices.

Should we see the continued strong growth in Li-ion uptake as the world moves towards electric vehicles, I believe there is potential for the nickel price to surprise a lot of people to the upside over the coming years.

Cobalt:I've touched on cobalt a lot this year because it's a metal with a very unique set of factors that affect its supply/demand balance, the key ones being:

Whilst technical patterns are never a guarantee of higher prices, a topside break over the coming few weeks would indicate continued buying pressure and would suggest the balance of probabilities has moved in favor of further price increases.

Lastly, we are moving towards the time of the year where the DRC political issues are likely to come to a head as the current president, Joseph Kabila, has promised that he will hold democratic elections by the end of 2017, something that now looks to be an almost impossibility.

Given the country is responsible for 60% to 65% of global mine production, there's the potential for us to see a serious impact to global supply should we see material unrest in the country.

In other words, if you're invested in the cobalt space, keep a very close eye on the DRC over the next four months.

Concluding comments:Just as night becomes day, bear markets are always authors of an ensuing bull market and it appears as though this process is finally playing out in the base metals sector. This is seen by the stagnant-to-decreasing supply environment now present across many of the world’s key industrial metals.

This has started to cause sharp moves in metals such as zinc and copper, price action that is typically associated with rallies driven primarily by constrained supply.

Whilst there is no guarantee that this breakout will continue, after almost a decade of declines the recent strong price action suggests it's time to (at the very least) pay close attention to the complex.

We favor companies at the exploration to development stage of the spectrum given we see reserve replacement being arguably the key issue for the sector moving forward.

However, given the prolonged bear market we've experienced, we see opportunities across the spectrum of explorers through to major miners.

On Aug. 21, President Donald Trump rolled out yet another U.S. strategy to try to bring closure to the war in Afghanistan. The core of the new strategy is based on the idea that U.S. support for Afghanistan is not unlimited and that Washington should not be engaged in nation-building in the country – even though it is not opting for a rapid withdrawal. Though Trump praised the Afghan government and its security forces, his remarks indirectly made the point that outside powers cannot build nations when the domestic stakeholders are not ready to agree on a constitutional order.

We wrote in May about how the U.S. military’s continued involvement in Afghanistan only delays the inevitable. When the U.S. military invaded Afghanistan in October 2001, it hoped to lay the foundations for a democratic Afghanistan. The new government was supposed to keep Afghanistan from again becoming a launch pad for transnational jihadists. Yet today, the jihadist insurgency is gaining ground quickly. Al-Qaida has been seriously degraded in the country, but the Taliban insurgency has kept growing, and the Islamic State is now increasingly active in many parts of the country. Adding 4,000 U.S. troops to the 8,000 already there will not make a difference. Even with 100,000 troops in the country as recently as 2011, Washington couldn’t quell the insurgency.

For years the U.S. searched for a strategy to justify its exit. It hoped that over time, with the support of American troops, Afghan security forces would be able to fight their way to a stalemate that would force the Taliban to the table. But Afghan security forces have never gotten over their chronic weaknesses. The blame cannot fall solely on the men and women in uniform, however; they are only as mature as the political system they are defending.

Warlord Government

Afghanistan’s more fundamental problem is that the central government has scarcely any influence over the rest of the country. Afghanistan hasn’t had a real state since its Marxist regime fell in 1992, and even then it was dealing with a serious insurgency. At that point, the Islamist factions that fought the communists and their Soviet allies turned their guns on one another – a conflict that gave rise to the Taliban. After the West toppled the Taliban regime after 9/11, it brought those old, mostly Islamist warlords together to form a democratic regime.

This effort – relying on a patchwork of warlords with only local or regional influence who didn’t even share ethnic and linguistic backgrounds – was never going to work. The only thing that bound the warlords together was their hatred of the Taliban. But the Islamic Republic of Afghanistan was founded anyway, and it muddled through the years of the Hamid Karzai presidency (2002-14), mostly because the U.S.-led NATO task force had a large presence in theater at the time. By 2014, with most of the Western troops gone and the shared fear of the Taliban long forgotten, internal rivalries bubbled to the surface.

The 2014 election to choose Karzai’s successor ended in controversy. Ashraf Ghani was declared the winner, but his victory was challenged by his rival, Abdullah Abdullah. Then-U.S. Secretary of State John Kerry pushed the two sides toward a compromise whereby Ghani would serve as president and Abdullah as chief executive. The arrangement was meant to be temporary until a more robust power-sharing mechanism through a constitutional amendment could be found. That hasn’t happened, and the deal has since expired, creating more infighting.

As if that weren’t enough, other warlords have entered the fray. The most notable is Pashtun Islamist insurgent leader Gulbuddin Hekmatyar, who, after years in the political wilderness, cut a deal with Kabul that allowed his movement, Hezb-e-Islami, to join the political mainstream. His return to politics hasn’t exactly restored calm to the country. For example, a few days ago he criticized the fact that some 600 military generals come from the mostly Tajik province of Panjsher. The Tajiks and Pashtuns have a long-running rivalry, and comments such as this undermine what little military power Kabul has. The Tajik Islamist party Jamiat-i-Islami, Hekmatyar’s historical rivals, reacted sharply, saying that he was sowing ethnic and linguistic discontent in the country.

Stay the Course

In addition to these divisions, the Afghan armed forces suffer from another problem: too many generals. In fact, the military has more than a thousand of them. The situation arose from the fact that top figures from so many different factions have been incorporated into the security system to keep the peace. But instead of advancing the national interest and fighting the Taliban jihadists, too many of these generals are focused on advancing their own partisan interests.

And this is the core problem of Afghanistan: It lacks a social contract to tie the various factions together. The U.S. military can’t hold this patchwork of a state together, and although the Trump administration has decided to stay the course, it’s unlikely that Washington will continue to squander resources like this for too long. A full withdrawal is not just the preferred course of action for Trump and his more ideological advisers – it’s also an option that is slowly gaining mainstream appeal.

U.S. President Donald Trump speaks during his address to the nation from Joint Base Myer-Henderson Hall in Arlington, Virginia, on Aug. 21, 2017. NICHOLAS KAMM/AFP/Getty Images

In a recent article in the Atlantic, noted realist scholar and MIT professor Barry Posen called for an American military withdrawal, which would force others Russia, Iran, Pakistan and others in the region to deal with the war-torn country. In such a scenario, the two countries that would play a lead role would be Pakistan and Iran. A U.S. withdrawal would lead to the collapse of a regime the West spent 15 years nurturing – hence why Trump’s strategy is based on a compromise between the president’s preference for a rapid pullout and the open-ended commitment his generals sought. This doesn’t mean the Taliban will soon come to power, but it does mean that Afghanistan would return to the intra-Islamist warfare that it experienced in the 1990s.

In years past, the battle lines were clear between the Taliban and the anti-Taliban factions under the old Northern Alliance umbrella. The situation today is far messier. The Taliban are internally divided and are being challenged by the Islamic State. On the other side, the factions that make up the anti-Taliban camp are at each other’s throats. The other governments in the region also don’t have clear sides. Pakistan no longer holds the influence over the Taliban that it once held and believes the rise of the Taliban will make its own jihadist problems worse. Pakistan would also risk greater anarchy if it cracks down on the Afghan Taliban sanctuaries on its soil as Trump’s new strategy demands, which means there will be a reckoning between Washington and Islamabad. Meanwhile, Iran, Russia and China have moved beyond simply siding with the enemies of the Taliban and have cultivated a significant degree of influence with the main Afghan jihadist movement.

The continued presence of American forces is delaying the tumult, but not for much longer. With the way things are going, Afghanistan’s dramatic unraveling will begin even with a U.S. military presence on the ground.

BERLIN – As someone who was born in 1948, the risk of a nuclear World War III was a very real part of my childhood. That threat – or at least the threat of East and West Germany both being completely destroyed – persisted until the end of Cold War and the collapse of the Soviet Union.

Since then, the risk of nuclear-armed superpowers triggering Armageddon has been substantially reduced, even if it has not disappeared entirely. Today, the bigger danger is that an increasing number of smaller countries ruled by unstable or dictatorial regimes will try to acquire nuclear weapons. By becoming a nuclear power, such regimes can ensure their own survival, promote their local or regional geopolitical interests, and even pursue an expansionist agenda.

In this new environment, the “rationality of deterrence” maintained by the United States and the Soviet Union during the Cold War has eroded. Now, if nuclear proliferation increases, the threshold for using nuclear weapons will likely fall.

As the current situation in North Korea shows, the nuclearization of East Asia or the Persian Gulf could pose a direct threat to world peace. Consider the recent rhetorical confrontation between North Korean dictator Kim Jong-un and US President Donald Trump, in which Trump promised to respond with “fire and fury” to any further North Korean provocations.

Clearly, Trump is not relying on the rationality of deterrence, as one would have expected from the leader of the last remaining superpower. Instead, he has given his emotions free rein.

Of course, Trump didn’t start the escalating crisis on the Korean Peninsula. It has been festering for some time, owing to the North Korean regime’s willingness to pay any price to become a nuclear power, which it sees as a way to ensure its own safety. In addition, the regime is developing intercontinental ballistic missiles capable of carrying a nuclear warhead and reaching the West Coast of the US, or farther. This would be a major security challenge for any US administration.

Ultimately, there are no good options for responding to the North Korean threat. A US-led pre-emptive war on the Korean Peninsula, for example, could lead to a direct confrontation with China and the destruction of South Korea, and would have unforeseeable implications for Japan. And, because the China-South Korea-Japan triangle has become the new power center of the twenty-first-century global economy, no country would be spared from the economic fallout. Even if the US continues to allude to the possibility of war, American military leaders know that the use of military force is not really a viable option, given its prohibitively high costs and risks.

When North Korea achieves nuclear-power status, the American security guarantee will no longer be airtight. A North Korea with nuclear weapons and the means to use them would add pressure on South Korea and Japan to develop their own nuclear capacity, which they could easily do. But that is the last thing that China wants.

The situation in Asia today has the nuclear attributes of the twentieth century and the national-power dynamics of the nineteenth century. That could prove to be a highly inflammatory cocktail. And at the same time, the international system is becoming increasingly unstable, with political structures, institutions, and alliances around the world being upended or called into question.

Much will depend on what happens in the US under Trump’s wayward presidency. The investigation into the Trump campaign’s possible collusion with Russia ahead of the 2016 presidential election, and the failure to repeal the Affordable Care Act (Obamacare) have shown the US administration to be unstable and ineffective. And agenda items such as tax cuts, the Mexican border wall, and the renegotiation of the North American Free Trade Agreement – to say nothing of Trump’s own emotional outbursts – are fueling America’s radical right.

Instability within the US is cause for global concern. If the US can no longer be counted on to ensure world peace and stability, then no country can. We will be left with a leadership vacuum, and nowhere is this more dangerous than with respect to nuclear proliferation.

Another nuclear danger looms this fall. If the US Congress imposes new sanctions on Iran, the nuclear agreement between that country and the P5+1 (the five permanent members of the United Nations Security Council, plus Germany) could fail. Iranian President Hassan Rouhani publicly announced just last week that Iran could abandon the deal “within hours” in response to new sanctions.

In light of the North Korea crisis, it would be the height of irresponsibility to trigger a gratuitous nuclear crisis – and possibly a war – in the Middle East. And a return by the US to a strategy of regime change in Iran would likely be self-defeating, because it would strengthen the country’s hardliners.

All of this would be taking place in a region that is already riven by crises and wars. And, because Russia, China, and the Europeans would stick to the nuclear deal, the US would find itself alone and at odds with even its closest allies.

Today’s nuclear threats demand exactly the opposite of “fire and fury.” What is needed is level-headedness, rationality, and patient diplomacy that is not based on dangerous and fanciful threats of force. If the last superpower abandons these virtues, the world – all of us – will have to confront the consequences.

If you know the other and know yourself, you need not fear the result of a hundred battles.

Sun Tzu

We are travelers on a cosmic journey, stardust, swirling and dancing in the eddies and whirlpools of infinity. Life is eternal. We have stopped for a moment to encounter each other, to meet, to love, to share.This is a precious moment. It is a little parenthesis in eternity.